13 / 11 / 23 - 8 minute read
Kermit the Frog, the ringmaster of The Muppets – an anarchical cast of puppet characters popular on the silver screen – once lamented in song that ‘it’s not easy being green’.
Property owners, managers and developers can sympathise. With governments under pressure to meet the Paris Agreement commitments [climate change goals seeking to limit global warming to 1.5°C], attention is swinging towards the role buildings play in producing carbon dioxide (CO₂).
Dan Williams, PATRIZIA Head of Real Estate Development UK & Ireland
The World Green Building Council calculates that buildings are responsible for 39% of global energy-related carbon emissions: 28% from the energy needed to heat, cool and power them, and 11% from materials and construction. According to research by Chatham House, the production of cement accounts for 8% of global carbon emissions.
As approximately 80% of buildings that will be standing in 2050 have already been built, existing stock must be decarbonised to achieve the European Union (EU) goal of ‘net zero’ by 2050. In cities like Brussels, London and Paris, authorities now discourage ground-up developments. Instead, they prefer older buildings be retrofitted – such as ensuring facades and heating/cooling systems are more energy-efficient.
Lord Deben, chairman of the UK’s Climate Change Committee, said in 2021: “We have to learn to make do and mend [instead of pulling down buildings as a matter of course].” When developers insist on starting from scratch, their plans can become the basis for complex calculations on embedded carbon.
Increasing awareness of ‘brown to green’ is reflected in the PATRIZIA Client Survey 2023. Some 85% of the 120 investors who responded believe brown-to-green development will increase over the next 12 months, of which nearly a quarter expect a significant increase. At the same time, two out of three anticipate an uplift in CAPEX and refurbishment programmes, reflecting growing investor focus on value creation through hands-on asset management.
“There is now a growing legislation framework driving this,” says Dan Williams of PATRIZIA.
“The EU sees renovating buildings as essential to avoid climate catastrophe and is pushing for energy efficiency in the sector and backing it with funds from the European Green Deal. Then you have 27 national governments setting their own targets for energy reduction, so momentum is building.”
As Head of Real Estate Development UK & Ireland, Dan works on refitting significant projects, including The Louise – an iconic 24-storey landmark office in Brussels. As part of the project, scheduled to be finished by Q1 2024, the complete façade and all mechanical and electrical equipment are being replaced. The extent of the sustainable refit has attracted heavyweight law firm, Clifford Chance, as the building’s anchor tenant when it opens.
Dan explains that the green push is primarily to reduce the energy used in buildings. Nearly two-thirds (62%) of building stock in the EU was built before 1980 and over 80% must be upgraded to achieve the 2050 sector goal of climate neutrality, but only about 1% of the EU’s building stock is renovated each year. According to a report commissioned by the National Trust, Historic England and property organisations, improving the energy efficiency of historical properties alone – those built before 1919 – could reduce carbon emissions from UK buildings by 5% each year.
As an example of the trend, Dan points to regulations that mean from next year, UK landlords cannot rent non-residential property if it holds an Energy Performance Certificate (EPC) of F or G rating. This has been in effect for residential since 2020.
The consequence is that buildings could become stranded; that is, fall victim to ‘brown discount’ (a loss in value due to not being ESG-compliant) if left untouched. Less energy-efficient commercial real estate, coupled with rising energy prices, will become difficult to let and sell, leading to reduced rental income and asset value.
“That is having a major impact on value,” Dan comments. “We’re seeing discounts already, and that will keep getting wider the closer we get to 2050.”
There are many ways a building can be made green for little cost. One is to procure more green energy sources or distributed green energy, such as by installing rooftop solar panels or via a power purchase agreement with energy producers. However, there are other relatively inexpensive ways, such as refurbishment and retrofitting works, which can include converting to LED lighting, adding heat pumps or installing a smart energy control system.
A combination of approaches is often adopted, but upfront costs and outlays associated with disruption to occupiers can be significant when more fundamental changes are required. The main reason building owners baulk at retrofits comes down to economics. Dan explains that most of the energy used in buildings goes out through the roof or the walls, which means projects may need to consider replacing the façades to obtain greater energy efficiency – which can be costly.
“Ironically, by replacing the façade for greater thermal efficiencies, you also lose embodied carbon, which is a negative,” he notes.
Dan Williams, PATRIZIA Head of Real Estate Development UK & Ireland
Arguments swirl around embodied carbon. While buildings have become more energy-efficient to run, massive amounts of energy are required during construction – and therefore, vast quantities of carbon are emitted. ‘Embodied carbon’ emissions include the materials and construction processes throughout the whole life cycle of a building and eventually demolishing it, such as transporting the waste and recycling it.
Retailer, Marks & Spencer, is currently challenging a decision to block its plans to demolish its 90-year-old flagship art deco store in London – plans previously approved by Westminster City Council, which have courted controversy on account of the 39,500 tonnes of carbon emissions it would create. To offset that, 2.4 million trees would need to be planted. From the perspective of achieving carbon neutrality, it makes more sense to refurbish such structures rather than build new ones – but not always. Developers often counter that new, more energy-efficient buildings will prove more carbon-friendly in the long term.
“You can end up with weird circular arguments concerning embodied carbon,” says Dan. “Yes, we should be reusing buildings, we shouldn’t be knocking them down, but the question arises: if you can’t reuse them, what do you do with them? This is particularly relevant when there is a housing crisis going on across Europe.”
Dan expects many offices will, for example, become redundant. With offices left semi-empty after the COVID-19 pandemic, on top of structural changes in working methods through the digital transformation, investors are reluctant to spend a small fortune retrofitting a building if it doesn’t tick all the boxes on property fundamentals, such as location.
The issue is complicated by the fact that office blocks often weren’t built with longevity in mind. The average life span was expected to be 25-30 years. As parts and equipment, such as lifts, air conditioning and windows wore out, landlords often opted for demolition over refurbishment.
Against the backdrop of the race to net zero, property owners and developers need to look again at the impact of construction and redo calculations concerning refurbishment and construction. When developers are looking to construct, says Dan, they need to look to the longer term – up to 100 years, which will also impact costs.
There’s no doubt the ESG imperative is understood by investors, with nearly 90% of PATRIZIA’s surveyed clients stating they collect and use the ESG data from their real estate investments.
However, the uncertainty of going green is having an impact on investors’ decision-making. Dan says many investors will now not go near a building that does not have a particular rating. Other property owners want to avoid the CAPEX of a major upgrade, so they seek to offload, especially as the pricing has been discounted.
Dan argues that this creates opportunities. “Despite reports to the contrary, the office market is not dead – but it is changing,” he states. “You can now buy good buildings in terms of location, but they need money spent on them to make them more ESG-compliant.”
PATRIZIA is involved in a number of refurbishment projects. Apart from The Louise, they include the transformation of a historic hotel at Tagus Square in Lisbon, a tower in Frankfurt, City of London offices and the redevelopment of a complex of listed buildings on 32,000 square metres in Berlin-Lichtenberg.
Dan says the company has experienced an uptick in redevelopment pitches in the last four months. A number of existing and potentially new clients have buildings with upcoming lease expiries where significant CAPEX is required to match new tenants’ expectations in terms of environmental standards.
“The beauty of us having an in-house development team is that most investment managers don’t offer this service,” he comments. “It’s been a real positive when we talk to clients because we can cover asset and fund management, fund services and development all-in-one and clients appreciate that.”
Dan says PATRIZIA is convinced that decarbonising buildings will make them more sustainable and be the main route for future-proofing assets. Historically, many within the real estate sector perceive climate-related risk as a negative – something that costs money, detracts from the value and reduces the life cycle of assets.
“We believe, and many clients agree, that brown to green is an opportunity to add value and to extend the life cycle of the asset, and for them to become more compliant with their ESG targets and to improve their ESG credentials,” he offers.
The results of the PATRIZIA investor survey also support a stronger focus on asset management, with the findings showing a shift in strategy and risk appetite, with debt, value-add and opportunistic ranked as the top three strategies where investors expect to increase allocations most over the next five years. These views underline a general trend towards modernising European real estate stock.
“We believe in the opportunity to move brown into green,” Dan says. “It is one of those rare examples where there is a strong investment case and, at the same time, it will make a real difference to cities, particularly with the climate crisis warning lights flashing already.”